Don’t Let This Recent Stock Split Fool You

Investors will notice that GameStop (GME -6.74%) shares are now trading below $50 per share, thanks to a four-for-one stock split the company just completed.

The game retailer remains a prime target for short sellers; more than 17% of outstanding shares are sold short.

Could this stock split be the catalyst for another short squeeze? Here’s what you need to know.

What does GameStop’s split mean?

In short, stock splits don’t change a stock’s fundamentals, but there are still reasons why companies do it.

Imagine you and three friends cut a pizza into four large slices, with each person getting a piece. Then four more friends come over and want pizza but there isn’t enough for everyone. So you and your three friends cut their slices in half to make eight smaller slices, enough to share with everyone.

Has the actual size of the pizza increased? No, but each slice got smaller so more people could have it. This is basically how a stock split works. GameStop’s four-to-one split means that each slice has been “cut” into four smaller slices. So if you had 100 shares before, you would have 400 after the split, but they will still total the same value as the original 100 stubs.

Companies use stock splits to make their shares more affordable to retail investors, which makes stocks more liquid In the process. A stock with a higher number of cheaper stocks is easier to buy and sell in the market.

Always refer to the fundamentals

More importantly, stock splits have nothing to do with a company’s finances, so they shouldn’t affect your decision to buy or sell a stock. It would be best to look at a company’s financials to see how the business is doing.

GameStop was a revelation last year; a historic short press sent the stock soaring. But even though the stock is far from its highs, you can see below how its enterprise value, the sum of its market cap and debt minus its cash, is still well above its long-term norms. despite a 25% drop in revenue.

GME Enterprise Value data by YCharts

Meanwhile, Free Cash Flow and Net Income are extremely negative and moving in the wrong direction:

Graph showing the decline in GameStop's free cash flow and net income since 2018.

GME Free Cash Flow Data by YCharts

In other words, the stock remains more expensive today than it was before, despite the noticeable deterioration in the company’s performance over time.

Is GameStop a buy today?

GameStop is one of the star children of the short-squeeze craze, which makes the title particularly volatile. It is certainly possible that investors will see a short-term upside due to the stock split.

However, fundamentals tend to dominate over time, and GameStop’s financials don’t paint an attractive picture. If you’re going to test the waters, use a diversified portfolio and know that GameStop is a very speculative stock to own.

For long-term investors, it’s hard to see a strong case for owning GameStop stock until the company can establish and sustain positive trends in its finances. There are better places to put your money in a bear market that is driving everything to the stake.

Justin Pope has no position in any of the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.

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